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Short-Dated Term Premia and the Level of Inflation

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Abstract

Since the advent of derivatives trading on short-term interest rates in the 1980s, financial commentators have often interpreted market prices as directly reflecting the expected path of future interest rates. However, market prices generally embed risk premia (or “term premia” in reference to measures of risk premia over different horizons) reflecting the compensation required to bear the risk of the asset. When term premia are large in magnitude, derivatives prices may differ substantially from investor expectations of future rates. In this post, we assess whether term premia have increased with the recent rise in inflation, given the historically positive relationship between the two series, and what this means for the interpretation of derivatives prices.

Suggested Citation

  • Richard K. Crump & Charles Smith & Peter Van Tassel, 2022. "Short-Dated Term Premia and the Level of Inflation," Liberty Street Economics 20220928, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednls:94848
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    File URL: https://libertystreeteconomics.newyorkfed.org/2022/09/short-dated-term-premia-and-the-level-of-inflation/
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    Keywords

    term premia; inflation; monetary policy expectations; Federal Open Market Committee (FOMC);
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G1 - Financial Economics - - General Financial Markets

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